Wednesday, June 15, 2011

Taking the model seriously

The critique part of the paper you refer to argued that the current core of macroeconomics has become so mesmerized with its own internal logic that it begins to confuse the precision it has achieved about its own world with the precision it has about the real one.

There is absolutely nothing wrong with building stylized structures as just one more tool to understand a piece of the complex problem. My problems with this start when these structures take on a life on their own, and researchers choose to “take the model seriously”—a statement that signals the time to leave a seminar, for it is always followed by a sequence of na├»ve and surreal claims. ...

Take, for example, the preferred “micro-foundation” of the supply of capital in the workhorse models of the core approach. A key parameter to calibrate in these models is the intertemporal substitution elasticity of a representative agent, which is to be estimated from micro-data. A whole literature develops around this estimation, which narrows the parameter to certain values, which are then to be used and honored by anyone wanting to say something about “modern” macroeconomics.

This parameter may be a reasonable estimate for an individual agent facing a specific micro decision, but what does it have to do with the aggregate? What happened with the role of Chinese bureaucrats, Gulf autocrats and the like in the supply of capital? A typical answer is not to worry about it, because this is all “as if.” But then, why do we call this strategy “micro-foundation” rather than “reduced-form”?

My point is that by some strange herding process, the core of macroeconomics seems to transform things that may have been useful modeling short-cuts into a part of a new and artificial “reality.” And now suddenly everyone uses the same language, which in the next iteration gets confused with, and eventually replaces, reality. Along the way, this process of make-believe substitution raises our presumption of knowledge about the workings of a complex economy and increases the risks of a “pretense of knowledge” about which Hayek warned us in his Nobel Prize acceptance speech.
--Ricardo Caballero, The Region, on knowing the model vs. knowing reality